Why The Cloud Is Critical To Apple's TV Strategy

It’s rumored once again Apple's next bold move is in the living room. We've heard this for years, but now the scoop is Apple will redesign Apple TV around iOS (think iPhone without a screen). This makes sense, since iOS and the A4 have all the processing and HD graphics power needed for HDTV. But absent a completely new cloud strategy, such a device would be dead on arrival. Here’s why:

Apple TV is priced at $229, supporting 160GB of local storage—a price which has proven way too high for mass market living room adoption. Speculation is that the device would need to be around $99 (Roku's price), and certainly not higher than $149.

Apple’s gross margins typically hover around 50%. A $99 Apple TV would need to have a bill of materials (BOM) of $50 in order to meet margin requirements. At $149, the BOM would need to be $75. So the question becomes – is it even feasible for an iOS-powered device to meet these cost targets?

iSupply estimates that the iPhone 4 costs $188. Most chips on the front and back sides of the iPhone 4’s circuit board can be removed including the GSM circuitry, GPS, gyroscope, touch screen controller and camera sensor. Apple TV doesn’t need these, but even removing all of them (as well as the battery and screen) only lowers the base cost to $99—still way too high, since to maintain 50% margin, Apple would need to charge about $200.

By embracing a cloud strategy and streaming music and video, the flash memory can be removed, since local storage wouldn’t be needed. Removing the flash lowers the BOM to $72 (and 16GB of Flash isn't nearly enough for video storage anyway) . At $72 cost, Apple could comfortably sell Apple TV for $149 and make about 50% margin, or bring the price as low as $119 for 40% margin. Certainly component costs will keep going down, so it's easy to envision a $50 BOM and $99 Apple TV.

This is a simplistic analysis, but it really is this simple from an economic standpoint. A cloud-centric streaming model is imperative for mass adoption of any device Apple produces for the living room. It’s also unlikely Apple would adopt the razor blade model and sell Apple TV below margin requirements, attempting to make up money on content subscription revenues. Apple has never been known to do this with hardware.

So it’s almost certain that an iOS / A4-based Apple TV is on the horizon, but it will only be ready once Apple completely revamps iTunes for the cloud. Buying streaming music provider LaLa was surely aimed at accelerating advancement in the living room. Once Apple can secure subscription deals with content providers, build out their data center and CDN strategy, and move beyond a local storage model, they should have all the pieces to price Apple TV aggressively and take the living room by storm.